Outcome or Process Oriented?

The non-Taper, the Lehman anniversary, oh, and our little launch has kept your humble author rather busy. Since its Friday, the day I like to get all philosophical on y’all, let’s reflect on a simple issue: What is more important to investors, their process or their results?

Given the amount of emphasis The Street puts on results, it is no surprise that Outcome dominates.

Consider:

“The reason investors and the investment industry rely on performance is because it’s simple, objective and easy to measure. But more importantly, performance goals, performance reviews and performance measurement are so common in business, in sports, in education, in investing—almost everywhere—that not using them feels uncomfortable.”

In broad strokes, what Jaffe is suggesting is dead on. However, I suspect there are more nuanced wrinkles involved.

Wall Street appears to be selling outcome, but thats illusory. What they are really selling is potential results. They are luring investors in by selling the possibility of out-performance, and not the actual out-performance itself. After all, how many managers receive the wildly misnamed “incentive fees” even when they under-perform? The incentive, to be blunt, is to bill 2&20 on as many assets as possible. This is not the sort of fee outcome most investors really thought they were signing up for.

Then there is meta-performance — why do you imagine you have the skills to pick the managers who will out-perform? Experience teaches us that most don’t; those fund of fees that charge an additional fee on top of fees not only can’t pick managers that consistently out-perform, their additional fees make the task nearly impossible.

When you consider the alternative — evaluating process — most investors (including many pros) simply lack the skill set to proceed. It has a degree of subjectivity; it relies on statistical analysis that is often counter-intuitive. And perhaps most difficult of all, it requires the abdication of traditional investing myths. To quote Jaffe, “Process is a much better predictive tool in the search for future success—and the most successful people in their fields focus on it and only it.”

Process focused investors shift the usual thought process. They create a different perspective from the usual analytical framework. I have yet to see anyone make good investment decisions based on evaluating queries Sharpe ratios and biggest draw downs, but that has not stopped a cottage industry of consultants from relying heavily on those and related mostly useless questions.

Its not just that “Past performance is no guarantee of future results.” Its that it is an actively misleading goal, a dangle of which you have precisely zero ability to evaluate.

Hence, the best practice for both individual and institutional investors is to focus on the investment process, and not the outcome.